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Currency risk with foreign holdings


orion
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I´m living in Germany and whenever I invest in some foreign stocks (US, Canada, etc.) I have a  currency-risk. I have no idea what the EUR/Dollar will do in the future, and I have no interest to speculate.

 

Currently, whenever I invest in some US stocks I convert just 50% of the Dollar-amount. Therefore I´m neither completely wrong nor completlely right. How do other members of this board manage this problem?

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I'm with Hielko, I don't want to take a concentrated bet on the USD, a lot of my investments are in it, my home is in it, and I get paid in it, so holding a bit of something different is good.

 

Over the long run, 15 years or more currency movements tend to wash out. Look at the Tweedy Browne international portfolios long term performance. I don't have the link but they show the results hedged in USD and unhedged. In the short term there are fluctuations but going past 10 years the returns start to converge, at 15 years there is almost no difference.

 

If you're thinking if sticking in these markets for the long term I wouldn't worry about it. If you're just looking for shorter term trades then hedging might be appropriate.

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Generally, I look at PPP. Right now, according to Bloomberg, PPP would be reached at EURUSD = 1.15. So, every time the exchange rate is above 1.15, I just don’t worry. If it happens to fall below that level, I calculate the rate of return expected from my investments, subtracting the percentage points required to get back to the PPP level.

At least, that is theory…

In practice, I just treat my USD dollar exposure as another kind of protection: every time the market decline, the USD appreciate against the Euro; every time the market rallies, the USD depreciates against the Euro. So, I calibrate the amount of cash in my firm’s portfolio and its short exposure, taking into account that both its longs and its shorts are USD denominated.

Let’s put it this way: if we were in a secular bull for stocks, I would stick with “the theory”. Instead, because I think we are still in a secular bear for stocks, I follow “the practice”.

 

giofranchi

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I'm with Hielko, I don't want to take a concentrated bet on the USD, a lot of my investments are in it, my home is in it, and I get paid in it, so holding a bit of something different is good.

 

I'm sorry I don't understand your point - but I've heard similar things from many people smarter than me so there must be something there.  My naieve thinking is that, if over the course of one's life one's standard of living will be paid for 90%+ in USD (living in the US, buying services in the US, etc.), wouldn't one want to be very concentrated in USD?

 

I've spent 10 or 20k euros in my life, a couple 100k yen, a handful of pounds, loonies, kroners, francs, and some Afghanis.  And waaaay more USD.  Figure my currency concentration should match the spend profile.

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I'm with Hielko, I don't want to take a concentrated bet on the USD, a lot of my investments are in it, my home is in it, and I get paid in it, so holding a bit of something different is good.

 

I'm sorry I don't understand your point - but I've heard similar things from many people smarter than me so there must be something there.  My naieve thinking is that, if over the course of one's life one's standard of living will be paid for 90%+ in USD (living in the US, buying services in the US, etc.), wouldn't one want to be very concentrated in USD?

 

I've spent 10 or 20k euros in my life, a couple 100k yen, a handful of pounds, loonies, kroners, francs, and some Afghanis.  And waaaay more USD.  Figure my currency concentration should match the spend profile.

 

Olmsted,

if I tell you that I live in Italy and that all my firm’s investments are nonetheless USD denominated… do you think I am agreeing with your point of view… or disagreeing?!  ???

 

giofranchi

 

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I'm with Hielko, I don't want to take a concentrated bet on the USD, a lot of my investments are in it, my home is in it, and I get paid in it, so holding a bit of something different is good.

 

I'm sorry I don't understand your point - but I've heard similar things from many people smarter than me so there must be something there.  My naieve thinking is that, if over the course of one's life one's standard of living will be paid for 90%+ in USD (living in the US, buying services in the US, etc.), wouldn't one want to be very concentrated in USD?

 

I've spent 10 or 20k euros in my life, a couple 100k yen, a handful of pounds, loonies, kroners, francs, and some Afghanis.  And waaaay more USD.  Figure my currency concentration should match the spend profile.

 

Olmsted,

if I tell you that I live in Italy and that all my firm’s investments are nonetheless USD denominated… do you think I am agreeing with your point of view… or disagreeing?!  ???

 

giofranchi

 

Sorry,

That was way too hermetic…  ;D What I mean is this: if the companies I like the best are in the US, I don’t care if my spending profile is in Euro. On the other hand, I agree with you that, if I lived in the US, all my investments would be USD denominated!

Hope now it is clearer!

 

giofranchi

 

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I'm with Hielko, I don't want to take a concentrated bet on the USD, a lot of my investments are in it, my home is in it, and I get paid in it, so holding a bit of something different is good.

 

I'm sorry I don't understand your point - but I've heard similar things from many people smarter than me so there must be something there.  My naieve thinking is that, if over the course of one's life one's standard of living will be paid for 90%+ in USD (living in the US, buying services in the US, etc.), wouldn't one want to be very concentrated in USD?

 

I've spent 10 or 20k euros in my life, a couple 100k yen, a handful of pounds, loonies, kroners, francs, and some Afghanis.  And waaaay more USD.  Figure my currency concentration should match the spend profile.

Just because you are using USD to pay doesn't mean that those costs are true USD liabilities. If the oil price remains constant in euro's but the dollar loses value compared to the euro the cost of putting fuel in your car goes up if you are living in the USA. That you are paying these costs in USD doesn't really matter. Same king of logic applies to a lot of products. So many things use inputs from global markets. You could for example probably see having some renminbi exposure as a hedge against increasing electronic prices.

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Guest hellsten

As a long-term investor I'm not too worried about currencies. All my holdings are in USD, CAD and EUR. If I owned some smaller currencies I would be more worried.

 

Anyway, maybe Bill Ackman based his Hong Kong Dollar trade on the Big Mac index :)

http://media.economist.com/images/images-magazine/2010/30/fn/201030fnc885.gif

 

Source:

http://www.economist.com/node/16646178

 

Warren likes the USD more than most currencies and Bill Gates seems to like the CAD:

http://video.cnbc.com/gallery/?video=3000088654

 

Warren is not hedging currencies either, but as a small investor I wouldn't draw any conclusions from that.

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Just because you are using USD to pay doesn't mean that those costs are true USD liabilities. If the oil price remains constant in euro's but the dollar loses value compared to the euro the cost of putting fuel in your car goes up if you are living in the USA. That you are paying these costs in USD doesn't really matter. Same king of logic applies to a lot of products. So many things use inputs from global markets. You could for example probably see having some renminbi exposure as a hedge against increasing electronic prices.

 

Yep, good point, I was waiting for someone to bring up the oil example.  Hadn't thought of the renminbi as a hedge on electronics.  In theory I agree - but in practice a lot of these are impractical to spend much time thinking about.  If this were a big concern, it would be more effective to go buy futures - but that's really kind of getting goofy unless you're a large industrial user.  I still think these are somewhat minor compared to all the goods and services we buy that are not so clearly dependant on exchange rates.

 

Gio - I hear you.  Focusing on buying the best out there definitely is the biggest return on a marginal unit of effort.

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Guest hellsten

Mr. David Hay on the importance of the currency in which investments are denominated.

 

giofranchi

 

Thanks. He also likes the CAD and perhaps the CNY and HKD?

 

Consequently, what might be the biggest asset allocation decision investors need to make is not whether to hold stocks or bonds but rather in which currency to hold them. Because the central banks in Europe, the UK, and Japan are also in full debasement mode, many of the obvious alternatives to the dollar don’t solve the inherent problem. In fact, the euro and the yen may perform even worse.

In my opinion, most investors seem oblivious to the importance of the currency in which their investments are denominated. Some clients who share my abhorrence of current US policies have suggested going into cash but that doesn’t solve the currency problem. It is also guaranteed to lose money even at today’s controlled inflation level. There are far superior vehicles available to protect against the Fed’s determined dollar degradation intentions.

 

A 3% cash flow yield paid in a currency that is likely to be heading north rather than south. Sounds appealing, eh? That’s why we are increasingly going north to Canada—and east to Asia—to protect our clients from Mr. Bernanke’s frenetic efforts to “rescue” our economy.

 

Soros might know something about currencies:

http://www.spiegel.de/international/europe/spiegel-interview-with-george-soros-you-need-this-dirty-word-euro-bonds-a-780189-2.html

 

SPIEGEL: As an investor, would you still bet on the euro?

 

Soros: I certainly would not short the euro because China has an interest in having an alternative to the dollar. You can count on China to back the efforts of the European authorities to maintain the euro.

 

SPIEGEL: Is that the reason why the euro is still so strong compared to the dollar?

 

Soros: Yes. There is a mysterious buyer that keeps propping up the euro.

 

SPIEGEL: And it is not you.

 

Soros: It is not me (laughs).

 

Jim Rogers might know something too:

http://video.cnbc.com/gallery/?video=3000110899

 

Jim Rogers explains why he owns the U.S. dollar even though he thinks all paper currencies are in trouble

 

 

http://www.theglobeandmail.com/report-on-business/top-business-stories/jim-rogers-sees-canadian-dollar-as-one-of-the-best-currencies/article4085166/

 

Rogers pumps loonie Jim Rogers believes the Canadian dollar is "one of the best currencies around." Having said that, the renowned investor also has faith in the euro, and we'll have to see how that plays out this year.

 

Mr. Rogers made the comments today on CNBC, which noted he also recommended the euro last November, only to see it drop.

 

It's clear the US will debase their currency. Europe is going to do it too. Everyone will. I put currencies in the "too hard" pile and I don't think anyone can predict where currencies are going.

 

With that said, BYD (1211.HK) is traded in HKD and the stock has doubled since November. I'm kicking myself for not buying it then. If Ackman thinks the HKD is undervalued and Munger has 60% of the family money in the stock then it might have been a good investment. It might still be :)

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With that said, BYD (1211.HK) is traded in HKD and the stock has doubled since November. I'm kicking myself for not buying it then. If Ackman thinks the HKD is undervalued and Munger has 60% of the family money in the stock then it might have been a good investment. It might still be :)

 

Well, it surely might! But I don’t know anything about electric cars… and I don’t invest in a company I know nothing about, just because someone I admire has invested… Most of the times for the worse: I didn’t invest in BAC, though everybody else suggested me to do so, because I couldn’t find the time to dig deep enough into BAC!  >:(

Vice versa, I think I know a thing or two about value investing.  ;) And also Fosun International is denominated in HKD. If I had to choose, I would invest in Fosun. But I am not in a hurry to do so. I will study carefully what they do and keep them monitored for a long time. Then, if I really like what I see, and the right opportunity comes, I will finally pull the trigger.

 

giofranchi

 

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I found the article to be a bit confusing. As far as I know, the currency in which a stock is "denominated" is largely irrelevant. A company like Shell has shares denominated in pounds, euro's and dollar. Whichever share you buy, you still end up with exactly the same piece in the same company. Arbitrageurs will make sure that if the dollar strengthens, the share price denominated in dollars goes down etc. There are only two relevant questions:

 

1. What are my cashflows, do I hedge those.

2. What effect does a move in currency have on the underlying business (e.g. a strengthening USD is probably bad for exporting companies)

 

To give an example: I live in Europe. Suppose I have a euro account with my bank. I can either buy Shell in euro's. Or buy the US listing, denominated in USD. If I do the latter, my bank will convert a couple of my euros to dollars using the prevailing spot rate and use those dollars to buy the US listing. In both cases I end up with exactly the same position: long euro's and long 0.00001% of a business called Shell. I have no exposure to any euro-dollar move.

 

This is the case for 90% of all retail accounts. Only with some brokers like IB you have subaccounts for different currencies. I.e. if I deposit 2000 euro's and buy Herbalife for 1300 dollar, I have three positions:

 

- long 1000 euro (approx, given eur/usd = 1.3)

- short 1300 dollar

- long herbalife

 

In this case you do have currency exposure. And I usually hedge it because most brokers charge ridiculous interest rates on negative cash positions. You could use futures to maintain the currency exposure if you want to but that's a bit of a hassle.

 

If you think a stock is a good investment because it is "denominated" in HKD, think again. This is irrelevant. For all I know Berkshire could have a HKD listed share and it would be exactly the same as the US listing. Because if the currency moves the price of the stock will change, but not it's value (as long as they don't to business in Hong Kong).

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I found the article to be a bit confusing. As far as I know, the currency in which a stock is "denominated" is largely irrelevant. A company like Shell has shares denominated in pounds, euro's and dollar. Whichever share you buy, you still end up with exactly the same piece in the same company. Arbitrageurs will make sure that if the dollar strengthens, the share price denominated in dollars goes down etc. There are only two relevant questions:

 

1. What are my cashflows, do I hedge those.

2. What effect does a move in currency have on the underlying business (e.g. a strengthening USD is probably bad for exporting companies)

 

To give an example: I live in Europe. Suppose I have a euro account with my bank. I can either buy Shell in euro's. Or buy the US listing, denominated in USD. If I do the latter, my bank will convert a couple of my euros to dollars using the prevailing spot rate and use those dollars to buy the US listing. In both cases I end up with exactly the same position: long euro's and long 0.00001% of a business called Shell. I have no exposure to any euro-dollar move.

 

This is the case for 90% of all retail accounts. Only with some brokers like IB you have subaccounts for different currencies. I.e. if I deposit 2000 euro's and buy Herbalife for 1300 dollar, I have three positions:

 

- long 1000 euro (approx, given eur/usd = 1.3)

- short 1300 dollar

- long herbalife

 

In this case you do have currency exposure. And I usually hedge it because most brokers charge ridiculous interest rates on negative cash positions. You could use futures to maintain the currency exposure if you want to but that's a bit of a hassle.

 

If you think a stock is a good investment because it is "denominated" in HKD, think again. This is irrelevant. For all I know Berkshire could have a HKD listed share and it would be exactly the same as the US listing. Because if the currency moves the price of the stock will change, but not it's value (as long as they don't to business in Hong Kong).

 

writser,

you brought up a good point with the Shell example. But that’s just an example. Many situations might be different. Think, for instance, about your cash reserves: let’s say a company has listed shares only denominated in USD. And you are waiting for a good entry point, maybe 50% below the actual price… Ok, 50% is way too much, but it just simplifies the math: with 1 Euro right now you could buy 2 shares, instead with 1 Euro you want to buy 4 shares. Now the market experiences a 50% correction and your stock just follows the market down the same amount. If the exchange rate EURUSD is unchanged, you actually meet your objective of buying 4 shares of the company with 1 Euro. On the other hand, if the USD strengthened against the Euro (like it usually happens during a market correction), let’s say the USD is up 25% against the Euro, with 1 Euro you can now buy just 3 shares of the company. Had you put your cash reserves in USD, instead of keeping them in Euros, after a 50% decline in the stock price, you would be able to buy 4 shares. So, one way you end up owning only 3 shares of the company, the other way you end up owning 4 shares.

Currencies do matter.

 

giofranchi

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But your example would also hold if your stock was listed only in EUR or HKD. If you think a long USD position protects you in a bear market you should shift some of your assets into dollars. But thas is something different than hedging your currency exposure. You are in fact creating currency exposure because you have an opinion about the market.

 

I am just trying to point out that if a stock is denominated in HKD it is not a better investment because the currency is weak. Whether I buy it in HKD, EUR or USD doesn't matter. The currency is just a medium of exchange, the value is in the partial ownership of the company. The only currency risks you incur are the risks present in the operating business and the balance sheet of the company you buy.

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